Uncharted Territory

June 2, 2012

Grexit? Spout? No, better half-in, half-out!

I’m not a huge admirer of Margaret Thatcher, and still less of her Chancellor, Nigel Lawson. But, back in the day, they suggested the eminently sensible idea of “currency competition” as an alternative to European Monetary Union (or, rather aptly, EMU). The idea was that the euro would be introduced alongside the pound, franc, mark and so on, with markets deciding the extent to which the international currency displaced the national currencies. But did the eurocrats listen? No, like improbably large flightless birds, they simply buried their heads in the sand.

The time for currency competition has now arrived. The case is compelling. So compelling in fact that when I scour the web to check my (in fact accurate) recall of the origin of the idea of currency competition in the eurozone, I find that it’s already been suggested as a solution to the current crisis – an alternative to Greek exit from the euro (Grexit) and Spain out (Spout) – by Philip Booth at Conservative Home. The existence of Professor Booth’s contribution allows me to make this post a little shorter than it would otherwise be. He also points out something I hadn’t previously realised – that it would be necessary to enact “a simple constitutional change to remove the clause in the EU constitution that requires the euro to be the sole legal tender currency in eurozone countries.” Actually that seems to put a small spanner in the works – is there no limit to the stupidity and lack of foresight of the eurocracy?

What would happen is this. In the (extremely likely) event that the Greeks do not vote on June 17th for parties willing to stick to the country’s agreements with its creditors, the EU (and IMF) would say to Greece that no more euros are to be made available from, say, 1/1/13 (to allow for necessary preparations). Greece nevertheless wants to stay in the euro. The conditions would be these:

  • All euros in circulation in Greece remain as euros. New bank accounts in drachma are created alongside for those who need them. Euro debts remain euro debts. And the Greek governments euro debts remain payable (it’s too late, unfortunately, for those that have already been forgiven).
  • Drachma are issued by the Greek central bank, subsequently backed by drachma bonds made available to the domestic market (I say domestic as international lenders are likely to be somewhat sceptical). The drachma floats freely against the euro.
  • Greece starts paying public sector workers, domestic contractors and state beneficiaries (the unemployed, pensioners etc) in drachma. The private sector has a choice. But companies (say in tourism) with euro debts and euro income would have no need to change their main operating currency. Such Greek exporters are not part of the problem – they can and should remain part of the European single market. It’s the Greek government that is bankrupt. The problem is the Greek public sector, not the private sector.
  • All Greek shops (and domestic businesses) would be obliged to accept both euro and drachma at an official market rate, say the previous day’s closing mid-market price.
  • Greece continues to service its international euro debt and recapitalises its banks (in euros, though if drachma are provided, these would have to be immediately converted by the banks). The need for euros for this purpose would be a key factor in determining the value of the drachma and hence public sector wage and other costs. In return (and only if satisfied that the Greek banks are solvent) the ECB would continue to allow Greek banks to borrow from it.
  • In theory it doesn’t really matter what currency Greece collects taxes in (as they are convertible), but because of time-lags the tax currency should match the currency of the taxable event (i.e. if you’re paid in euro you pay taxes in euro). Note that the drachma is likely to inflate, so the public and companies are likely to want to convert to euro for savings purposes.
  • Greek import costs are similarly convertible, but since there may be few external holders of drachma, euro would effectively be required. Greece would be forced to balance its trade (and in fact achieve a surplus, given its debts) – and the drachma would fall until it did.

The goals of such a policy are of course to:

  • Stop the haemorrhaging of deposits from Greek, Spanish and Italian banks. This is taking place because of fear that such deposits will be forcibly converted to a weaker currency, such as the drachma.
  • Remove the need for further Greek and other bailouts.
  • Force Greece (and others) to take reponsibility for their own budget and trade deficits.
  • Allow wages and hence public-spending to adjust in Greece and any other countries that follow the same course.

My flavour of the idea is slightly different from Booth’s in that he doesn’t make such a clear distinction between the public and private sectors of Greece’s economy. What we have in common is the realisation that, as Booth puts it:

“There would be no doubt about the legal status of private debts and credits denominated in euro and little doubt about the legal status of Greek government debt (any doubts would revolve around whether it was denominated in euros or the ‘sovereign currency of the Greek government’ – most likely the former). There would be no capital flight – all euro deposits in Greek banks would remain euro deposits.”

I would say the policy exploits what George Soros terms “reflexivity”. That is, it creates the positive feedback that as soon as it becomes seriously discussed it becomes less worthwhile for Greeks (and Spaniards and Italians) to move their euro bank deposits to Germany, making the policy itself easier to implement.

Note that this desirable reflexivity is in marked contrast to the historically stupid decision to haircut private lenders to Greece, which had the fairly predictable consequence of raising the costs of borrowing by other euro countries perceived by the market to be weak.

I call this the “half-in, half-out” or “Hiho” plan for restoring some kind of normality to the economies of the eurozone’s ailing members and to get the overall European economy moving again. As the ditty goes: “Hiho, hiho, it’s off to work we go!”

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